Indifferent point Debt, Equity Capital
The indifference point is employed to determine a firm's optimal capital structure. As seen earlier, business firms opt for two kinds of financing in terms of long term financing Debt and Equity. When the business firm has equal earnings per share from both the financing options, it is known as an indifference point.
Indifferent point or level is that EBIT level at which the Earnings Per Share ( Earnings Per Share) is the same for two alternative financial plans. The indifferent point can be outlined as "the level of EBIT beyond which the gains of financial leverage start out to operate with respect to Earnings Per share ( EPS). If the EBIT exceeds the indifference point level of EBIT, the use of fixed-cost source of funds would be beneficial from the Earnings Per Share viewpoint. In such cases, financial leverage would be pleasing. In the inverse scenario, if the countered level of EBIT is less than the indifference point, the reward of Earnings Per Share would be available from the use of equity capital and not debt capital.
The point of indifference can be computed employing the following formula:
Where:
X = EBIT indifference level
I1 = Fixed interest costs under alternative 1.
I2 = Fixed interest costs under alternative 2.
PD = Preference dividend, if any.
T = Tax rate
S1 = Number of equity shares outstanding under alternative 1.
S2 = Number of equity shares outstanding under alternative 2
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